Remember the Detroit auto bailout, when the federal government improperly rewarded favored constituencies like labor unions in violation of secured creditors’ contractual rights?

The Obama Administration’s conduct flatly violated well-established American legal principles, and unfairly robbed private investors who had placed themselves at great risk.  When bankruptcy arrived, the Administration bullied secured creditors into accepting their agenda that favored unsecured creditors like the United Auto Workers and other political constituencies.

{mosads}Today, a disturbingly similar situation is unfolding as the federal government attempts to end the roles of Fannie Mae and Freddie Mac in the home mortgage market.

To be sure, the names Fannie and Freddie understandably trigger visceral skepticism from Americans who connect them with the housing bubble and recession.  For years leading up to the market collapse, politicians like former Rep. Barney Frank (D-Mass.) exploited Fannie and Freddie to push their partisan social agenda, such as propagating subprime mortgages, while creating an implicit taxpayer backstop.  In other words, politicians forced Fannie and Freddie to take risks, then hung taxpayers on the hook when the collapse occurred.

After that experience, many Americans might reflexively support the elimination of those government-sponsored enterprises’ (GSE) roles in the home mortgage market.

Here’s the problem:  Current proposals in Congress could end up putting taxpayers at even greater future risk, while granting even more power to large banks – does “too big to fail” ring a bell? – in the mortgage liquidity market.  In the process, those proposals also jeopardize the rights of private investors who were encouraged by federal regulators to take risks to shore up Fannie’s and Freddie’s capital.

In the House, the PATH Act sponsored by Rep. Jeb Hensarling (R-Texas) liquidates Fannie and Freddie, but in the process would put trillions of dollars in liabilities – $5 trillion by some estimates – back on the federal government’s balance sheet by providing an explicit guarantee of their existing assets.  That constitutes an unprecedented move by the federal government, as it not only fails to relieve American taxpayers of lending risks, but actually makes them responsible for those risks by law.  Keep in mind that even in 2008, when Fannie and Freddie required $187 billion in emergency capital, the federal government did not explicitly guarantee all assets.  Accordingly, if such an explicit guarantee didn’t exist at the height of the crisis in 2008, when the GSEs were under water and the economy was deteriorating, it certainly isn’t appropriate going forward with those recent lessons in mind.  That is particularly true in light of the fact that taxpayers are scheduled to become fully repaid from the bailout as soon as next year.

In the Senate, meanwhile, the Housing Reform and Taxpayer Protection Act of 2013, sponsored by Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.), seeks to abolish the Federal Housing Finance Agency (FHFA) and transfer all responsibility to a new federal agency named the Federal Mortgage Insurance Corporation (FMIC).  The bill would eliminate Fannie and Freddie, but still provide a government backstop based on the same old “too big to fail” notion.  In other words, the bill simply creates a new federal insurance program, one tied so heavily to such a large portion of the mortgage market that it would likely become just as unsustainable and keep taxpayers on the hook for the bulk of mortgage lending.

Moreover, as referenced above, both proposed bills fall terribly short in terms of protecting the rights of private investors in Fannie and Freddie, many of whom were actively encouraged by federal regulators to take their risk.  Not only would it be inherently unfair for the federal government to undercut their bargained-for investment rights, it would also send a terrible signal to future investors.  When even Ralph Nader laments that the federal government unfairly threatens to turn those private investors into “zombies,” the impropriety of the government’s proposed course becomes even more obvious.

Accordingly, if Congress seeks to eliminate both GSEs, then using something approximating the existing bankruptcy process would be a far better option for all involved.  Under that process, the government, taxpayers and creditors would be treated more fairly, and taxpayers would not be stuck with trillions in liability.   While not ideal, at least that would constitute an orderly and transparent process, one that more closely adhered to the rule of law on which our society is ostensibly based.

Unfortunately, neither of the two proposed bills in Congress sufficiently protects taxpayers against trillions of dollars in future risk.  Nor do they protect the rights of private investors, who suddenly face a repeat of the Detroit auto bailout fiasco.  Unless and until the bills are significantly revised, American taxpayers and private market investors stand to lose.

Lee is senior vice president of Legal and Public Affairs at the Center for Individual Freedom.